Should you Exit your ULIPs Now?

The title is a Million Dollar question isn’t it? The economic uncertainty in the Euro Zone and USA has affected the Stock Markets worldwide. Markets like India which attract a significant portion of foreign investors are highly sensitive to cash inflows & outflows from the markets. The past 2-3 years have been very strenuous on the Indian Stock Markets. We have witnessed multiple corrections & dips along with a few bursts of growth as well. At this Juncture, many of you, who had bought ULIPs in the past few years, might be wondering what to do with these products. Are you one of them? If so, this article is just for you…

Should you Exit your ULIPs now?

Well, this questions can’t be answered in a simple Yes or No across the board. We are going to split our investor population into two groups and answer this question depending on the situation they are in.

Category 1 – ULIP is less than 5 years old

These are the relatively new investors who have been investing in ULIPs only in the past few years. ULIPs as you might be aware are long term investment options and they also include high fees & charges during the first 2 – 3 years of its life. So, even if the stock market performs very well, a well-managed ULIP will reach the break-even point only around the 5 year mark. For ex: If you were investing 1 lakh every year, in all probabilities your investment will be worth around 5-6 lakhs by the end of 5 years even if the ULIP is performing exceptionally well.

In the last couple of years, the market has witnessed severe corrections and hence the value of your investment right now will be at least 10 to 20% or more lesser than what you had invested.

Moreover, Insurance Cos charge penalties if we withdraw our investments within the first 5 years (3 or 7 in some cases). So, at this point when the market is very volatile, exiting the investment would mean incurring losses. It would be advisable to stay invested and continue for at least a few more years and then reconsider your decision when your investment is 7 years old.

A 1 lakh investment every year will be worth the following amounts if it were to grow at different rate: (Invested Amount = 7 lakhs)

1. Growth @ 5% p.a = 8.5 lakhs
2. Growth @ 6% p.a = 8.9 lakhs
3. Growth @ 8% p.a = 9.6 lakhs

As you can see, if your investment grows at an average of 6% p.a rate of interest for those 7 years it will be worth 8.9 lakhs.
If you are in need of the money and your investment has grown by at least 6% on an average, it would be a good idea to exit the investment. But, until then, staying invested would be the best way to go.


Category 2 – ULIPs are More than 5 years Old

These are the Seasoned Investors who have been investing regularly for more than 5 years and by now are sitting on a handsome corpus (Assuming that their ULIP scheme has performed well). They have most probably crossed the mandatory holding period and can exit the investment anytime they want.

In the current market scenario exiting would make sense if:
1. You have some plans for the money you will get – Either to spend it on some cause (like children’s education, buying a home etc.) or to invest in some other instrument (like Bank FDs, PPF etc.)
2. Your Investment has grown at at least 6-8% or more on an average
Let’s take the same example where we invest 1 lakh every year. If our investment were to grow at 8% per annum it will be worth the following amounts:

a. At the end of year 6 = 7.9 lakhs (Investment = 6 lakhs)
b. At the end of year 7 = 9.6 lakhs (Investment = 7 lakhs)
c. At the end of year 8 = 11.4 lakhs (Investment = 8 lakhs)
d. At the end of year 9 = 13.4 lakhs (Investment = 9 lakhs)
e. At the end of year 10 = 15.6 lakhs (Investment = 10 lakhs)

So, if your investment has grown to approximately the amounts mentioned above, it would be a good idea to exit the investment right now. If your investment has only grown to be less than this, then the judgement call is yours. You can decide to exit the fund based on the current returns it has offered or opt to stay invested.

What about cases where we have crossed 5 years but the Investment isn’t worth even the amount we invested?

Did you think about asking me this??

Well, if so, the answer is – Stay Invested but do not make any fresh investments. Let’s say you have invested 1 lakh each year for 7 years and your ULIPs value right now is 6.5 lakhs, then don’t exit right now. You are at a loss of 50k and there is no point in exiting at a loss. So, you can do the following:

1. Stop making fresh investment contributions. Let us now add more money on a fund that hasn’t performed so well in the past 7 years or so
2. Don’t exit the fund. Let the investment of 7 lakhs stay as it is.
3. Switch your units to a Balanced option that invests equally (around 50%) in both Equities & Debt instruments to cushion & minimize further losses
4. Keep track of the ULIPs performance on a regular basis – say every month. Wait for the time when your investment breaks-even.
5. Give the fund another 6 months to 1 year to generate returns for you and the moment your investment is grown by at least 7-8% on a year-on-year basis exit the investment

A General Suggestion to all ULIP Investors

Irrespective of which category you fall into, whether you want to exit your investment or stay invested, whether you are going to make fresh investment contributions or not, the following suggestion will have a big impact on your funds risk/return ratio.
Most ULIPs give you options to switch between various investment options. At the given market scenario, being heavily exposed to the stock market is not a good idea. At the same time, too little exposure would be bad too because the market is sure to rebound and if you are in defensive mode when the market gets back on its feet, you will not get the growth or returns you want.
Switch Over to a Balanced Fund Option that invests equally in both Equities & Debt Instruments.
So, go for a Balanced fund option that invests around 50% or so in Equities and Debt Instruments. This way, at least 50% of your corpus is set up to be safe and the remaining 50% can help you attain good returns once the market recovers.

Happy Investing!!!

Budget 2012 - Income tax and Life Insurance

The Union Budget 2012 has been the focal point of the articles in our blog over the past few days. We have covered various aspects of Budget 2012 and the Tax implications on the Indian Citizen. Now, it is time to take a look at how the Budget 2012 impacts the Life Insurance section of Income Tax. Though there was no significant announcement about the Insurance Sector in our 2012 budget, there is one small change that waw tucked away in the corners of the budget. This change will have much bigger consequences. The purpose of this post is to cover those areas…

Before We Begin:

Insurance is nothing but an agreement between the insurer (The Insurance Company) and the insured (You) to pay an amount as compensation if any unexpected event occurs. This amount may vary from a few hundred to even a few crores. The maximum amount the insured person can claim depends on the amount agreed upon as per the insurance policy

To read more about Life Insurance Click Here.

What this Small Change?

All Regular Premium Life Insurance Policies issued after April 1st (Except Pension Plans) must offer a protection cover of at least 10 times the annual premium. Otherwise, they will not be eligible for Tax benefits under Section 80C.

Note: Until now, the mandated cover was five times the annual premium

What will be the Impact on the Common Tax Payer?

The Impact will be pretty big. All Insurance Policies, where the sum assured (In case of Death) is less than 10 times the annual premium will no longer be eligible for tax benefits under Section 80C of the Indian Tax Laws.

In other words, if your yearly premium is Rs. 50,000/- the protection cover in case of death must be atleast Rs. 5,00,000/- (5 Lakhs). Otherwise the policy premiums cannot be used for tax exemption under Section 80C.

Almost all Insurance Products (Except Pure Term Plans) will be affected by this ruling. Until this year, the mandated cover was only 5 times the annual premium and Insurance Cos created products that catered to this requirement. Now that the budget has changed this requirement to 10 times, most insurance policies will no longer be eligible for tax benefits.

The Impact will be:

1. We may have to look at availing fresh insurance policies to cover for the existing ones that we can no longer use for tax exemption which means – Additional Expenditure
2. What will we do with the existing policies that are no longer viable tax saving instruments? This will be a dilemma that everyone will have. Should I continue to pay the premium or should I surrender the policy? We will probably cover this as a separate post in future. For now, lets not worry about what to do with those policies.

What will be the Impact on the Insurance Company’s?

Insurance company’s will not have to come up with new products that meet the mandatory requirement of 10 times the annual premium worth of protection. The problem is, all those products that offer less than that, will no longer be useful to customers and hence they wont buy them. One of the primary motivating factors in the sale of insurance products it the tax benefit that comes with it. So, if by purchasing a policy, I wont get tax benefits, why in the hell would I buy it?

The impact will be:

1. Insurance Cos will have to come up with new products
2. There is mandatory approval period for any new policy that a company wishes to propose. IRDA takes some time to review the policy terms and approve it. So, in the meantime policy sales might take a hit
3. Policies that don’t offer this 10 times protection maybe targets for premature surrenders. Customers might choose to surrender their policies before maturity and insurance cos may face issues in meeting the liquidity demand if this number goes up.

Why did the Government Do This?

My Guess – To Prevent People from Using Insurance Policies as Investment

I have always been saying this “DO NOT CONFUSE INSURANCE AND INVESTMENT”

Insurance Cos and Agents have been selling insurance products as investments for decades. The government feels that the primary purpose of Insurance Policies is to provide financial support to the survivors of the insured individual. Any proceeds they get if they outlive the policy is only of secondary importance.

Impact on Various Categories of Insurance Policies

ULIPs and Endowment Plans will be affected as follows:

1. Insurance Cos will be forced to increase the % allocation from the premium amount towards mortality charges (Actual life insurance coverage) to account for the increase from 5 times to 10 times
2. This effectively means that the actual amount available to invest is going to come down (If the same annual premium is to be maintained)
3. If the Insurance co as well as the customer want to maintain the same levels of returns, the annual premium will be significantly higher

Money-Back Plans – These are the plans that in my opinion that will be worst hit. These have effectively been sold as exclusive investment options and they provide very little life insurance coverage. It is possible that the premiums on these policies will go up significantly (much more when compared to ULIPs or Endowment Plans) or such schemes may be scrapped altogether because of the technicalities involved in maintaining 10 times insurance coverage as well as providing good returns on investment.

Pure Term Insurance Plans – These are plans that will have ‘0’ impact due to this ruling. As pure insurance products, they offer a much higher insurance coverage than what is paid as the annual premium. For a premium of Rs. 15,000/- I can get around 30 lacs worth of Insurance. That is nearly 200 times the Annual Premium.


Some Last Words:

If Investment is your primary objective in buying Insurance Policies – then you are better off purchasing investment products like PPF, ELSS etc. With this New Ruling, the returns offered by Insurance policies will come down significantly. As a result, they will start serving their main purpose “Providing Life Insurance”

When Buying a Life Insurance Policy “Focus on life cover, and not on the investment component”

So, personally, I WELCOME THIS MOVE!!!

Are ULIPs becoming Obsolete?

Well, you might think I am crazy to ask such a question and I would be surprised if you dint… yes, you read the title right, are Unit Linked Insurance Plans becoming Obsolete?

The purpose of this article is not to tell you what an ULIP is or whether to invest in ULIPs or not. I have already dedicated a few of my older articles to do just that. You may want to visit them to understand them better.

1. Introduction to ULIPs
2. Can ULIPs Really Guarantee Returns

Are ULIPs Really getting Obsolete?

It has been a testing time for all equity market investors world wide. The stock markets are volatile and people are cautious before they invest their hard earned money in stocks. But, at the end of the day, stock market instruments are still one of the best preferred investment options for everyone.

But, it is such testing times that can spell the doom for certain investment options. In this case ULIPs or Unit Linked Insurance Plans.

Insurance Agents have been selling ULIPs like crazy and People have been buying them for years. In the past few months, Equity investments made by insurance companies went downwards, as policyholders surrendered some unprofitable old ones to shift to more attractive new products. To add to the woes of the ULIP sellers, regulatory changes did not help either.

The net investment from Insurance companies in the Stock markets was over Rs. 34,000 crores last year (i.e., They received that much money as ULIP premium) whereas this year in the first 3 months, they have invested a net of only around Rs. 3000 crores. More than 50% down than what they invested in a similar timeframe last year.

Per, last years numbers, by the end of March 2011, the insurance companies should have invested Rs. 8000 crores in order to atleast reach the numbers they achieved last year, but unfortunately they are not even 50% close to it.

This is because:
1. A lot of people surrendered their ULIP policies they had invested a few years back
2. People are not willing to buy new ULIPs because the existing ones haven’t lived up to their promises
3. People have started preferring traditional insurance policies rather than ULIPs


I personally have not been a big fan of ULIPs and you might have sensed it, if you are a regular reader of my blog. Even though I am not a big fan, atleast for the benefit of my readers like you, it is my duty to analyze what went wrong for ULIPs. Isn’t it?

What Went Wrong?

Well, the reasons are numerous. Let us look at them one by one…

1. ULIPs are not Magical Investment Instruments

This is true. ULIP is nothing but a combination of Mutual Funds and Traditional Insurance policies. Unfortunately the Agents who sold these ULIPs and the companies that floated them, did not explain the ground reality to their investors. Every insurance agent in town went around with extraordinary projected returns, extrapolated for the next 10 or 15 years. Unfortunately, our Insurance advisors conveniently forgot that the equity market is not an upward moving machine and the equity markets lived up to their reputation. The past 3-4 years have been extremely uncertain and people have realized that, their net investments are not even worth what they invested.

So, people have started surrendering their ULIP policies as soon as the lock-in period of 3 or 5 years are over.

To Meet the Surrender Demand, Insurance companies are forced to sell their holdings or divert the fresh inflows to pay off customers.

This is the biggest reason for their downfall – Promising Unachievable or Impossible Returns to Investors and Failing to Achieve them!!!

2. OverSelling ULIPs

Any product that is over-sold usually goes out of favour in due course of time. When ULIPs were introduced as a revolutionary investment option, every tom dick and harry was selling them and naive investors were buying them just like crazy. And as time went by and the craze started to fall off, the reality struck the investors and because they did not perform as well as they were supposed to, people started selling as well as avoiding them.

3. Profit Involved

ULIPs have been a very profitable instrument for the companies that floated them and the agents that sold them. The same cannot be said about the investors who bought them. ULIPs have the highest commission margin for agents that sold them and the highest expense ratio among equity investment instruments for the Insurance companies. Everyone made merry by selling them while the investors who bought them weren’t having so much fun.

4. Regulatory Concerns

The Equity Market Regulators (SEBI) and Insurance Regulators (IRDA) realized the fact that insurance companies were making a killing by selling these products and by not disclosing all facts concerning them. Investors were even given pamphlets that said how much their money would be worth over the next 5 or 10 years. When the regulators realized this, they started tightening the noose on the rules related to these hybrid investment products and when the free-run was no longer possible, insurance companies had to disclose all concerned facts which made ULIPs less and less desirable among investors

5. Lesser Profits for Agents

Because of heavy competition, insurance cos were forced to reduce their margin on ULIPs. They did so by cutting on the commission they paid to the agents who sold these policies. An agent who used to get upto Rs. 45000 for a policy investment of Rs. 1 lakh by an investor 3 years ago, gets less than 10% of the same today. Making it a not so profitable sale prospect for the agents and eventually the agents are not as excited as they were before to sell them today.

6. The Lock-In Period

ULIPs are long term investment options. They come with a basic lock-in period of 5 years or more. Investors have no choice but to keep investing for 5 or more years even if the ULIP they chose was sinking. Considering the high expenses & fees involved with ULIPs and also considering the fact that the equity markets were choppy, investors realized the fact that, the current value of their investments at the end of 5 years is lesser than what they had actually invested, they started surrendering their investments. This resulted in huge losses for the insurance companies that sold them.

Did Investors Make a Mistake?

If you ask me, the answer is YES. A big YES. It is the responsibility of the investor to perform proper due diligence before locking in money for such long durations (5 years or more) By believing whatever was told to them by the agents, people invested vast sums of their savings into these products and ended up burning their fingers.

After all, every single action we do has a monetary repercussion. People sell things to make a profit and I wouldn't blame the insurance cos or the agents for selling them like pancakes because they were making solid gains by selling them. It was the responsibility of the person who bought it to be careful, when that doesn't happen, people stop buying and that is exactly what has happened!!!

That's it for this article folks…

Happy Investing!!!

SEBI Bans Major Insurance Companies from conducting ULIP business

Many of us today have invested in ULIP plans with some top Insurance cum Asset Management Companies in India. These ULIPs span from retirement plans to children’s education and covering almost every aspect of investment for an investor. Last week, SEBI – the governing body for stock market investments had banned 14 of the top insurance companies in India from conducting business in ULIPs without its approval. We are going to dig deep as to what happened and how it would impact us…

SEBI vs IRDA face off

The Securities Exchange Board of India and the Insurance Regulatory and Development Authority have been mulling over the ULIP story for quite some time. There has been discussions between these two boards reg. regulation of ULIPs. It all started in January 2010 when SEBI issued a show cause notice to insurance companies asking them to explain why they did not seek the approval from SEBI before launching ULIP plans. The ULIP business has been flourishing in the Jan to March quarter because it is the financial year end and investors were scrambling to save income tax by investing in tax saving instruments.

With discussions going on between SEBI and IRDA and with no satisfactory response from IRDA and the insurance company, SEBI went ahead and banned 14 of the top fund management and insurance companies in India from conducting further business with these ULIPs

Why Ban ULIPs?

SEBI is the governing body for all stock market related investments and hence has the power to oversee any instrument that invests in the stock market. These ULIPs are special investment instruments that gives exposure to the stock market and gives insurance to the investor and hence many insurance companies have flouted ULIPs of their own. Since insurance companies are issuing these, the IRDA has been regulating them ever since their inception.

In January 2010 SEBI issued show cause notice to the insurance companies to explain why they did not seek SEBIs approval before launching these schemes and to get their approval for the same to continue with the ULIP business.

Insurance regulator IRDA is understood to have stated in its reply that regulation of ULIPS by IRDA is well-laid down and that it does not agree with Sebi contention that insurers need a certificate of registration from the market regulator for dealing in ULIPS.

Since ULIPs are issued by insurance companies, SEBI does not have full control over these instruments and hence wanted to regulate the ULIP segment and as it could not get satisfactory responses from IRDA it went ahead and Banned these insurance companies from doing business with ULIPs until cleared by them.

What are these 14 companies?

The 14 insurance companies are:-

• n Religare Life Insurance Company Limited
• Aviva Life Insurance Company India Limited
• Bajaj Allianz Life Insurance Company Limited
• Bharti AXA Life Insurance Company Limited
• Birla Sun Life Insurance Company Limited
• HDFC Standard Life Insurance Company Limited
• ICICI Prudential Life Insurance Company Limited
• ING Vyasa Life Insurance Company Limited
• Kotak Mahindra Old Mutual Life Insurance Limited
• Max New York Life Insurance Co. Limited
• Metlife India Insurance Company Limited
• Reliance Life Insurance Company Limited
• SBI Life Insurance Company Limited
• TATA AIG Life Insurance Company Limited

IRDAs reaction to the Ban

The IRDA rejected the market regulator Sebi's ban on life insurance companies to raise funds through unit-linked insurance policies (ULIPs) and asked them to do business as usual.

Where is this heading?

It is a tussle between the regulator for stock market investments and the regulator for insurance in India and it will go on for quite some time. In my personal opinion insurance companies are bound to be regulated by the SEBI because they are investing in the stock markets but at the same time SEBI cannot intervene in the business of Insurance cos as long as they abide by the investment laws of our nation.

What is the impact on us as an investor?

With this tussle between IRDA and SEBI expected to go on for some time, authorities from IRDA have come up with news statements to allay the fears of the investors. A simple question that would arise in any investors mind is:

“If ULIPs are banned by SEBI what will happen to my hard earned money that I have invested in it, especially after the huge crash in NAVs after the stock market crisis in the past two years”

J Hari Narayan, chairman of IRDA, has told reporters that, "Policyholders of the ULIPs offered by different insurance companies are assured that these policies are safe and secure and the matters arising out of the recent orders of the SEBI will be addressed expeditiously in the appropriate forum in accordance with Law."

Though, the chairman of IRDA has come up with a comforting press release, things are hardly settled. The regulator (SEBI) has been staying away from these ULIP plans for the past few years and out of the blue it has entered the fray and banned them because of lack of approval. A full fledged face off between IRDA and SEBI can be expected in the courts of Law in India.

What is the Finance Ministry's stand in this matter?

As of now the finance ministry is keeping a safe distance from this problem. But, it is rumoured that the Finance Minister would be briefed about the matter and we can expect a full stop to this struggle between IRDA and SEBI.

The Finance Secretary Mr. Ashok Chawla has told reporters that "It's a matter between regulators; so they have to decide"

What Next?

Industry Experts across the country are hoping for the finance ministry to enter the picture and clear the air and settle things down between the two regulatory bodies in a way that investor interests are not compromised.

Let us wait and watch!!!

Can ULIPs really guarantee returns

Of late the latest hype is about ULIPs guaranteeing the highest NAV in the first few years during maturity. Many people including me are wondering is this really possible? Can an equity market related instrument really guarantee the returns it generates? If that is the case, why do fund management companies have a fine print that says "Equity market investments carry a certain risk. Current performance may or may not be sustained in the future"

The main reason for fund houses to come up with such schemes is to attract more investors. The market for ULIPs and Mutual funds has become extremely competitive. A fund house that provides a marginally lesser returns than the market can find no takers in the subsequent years. People (we investors) have become very demanding and expect the fund manager to give us solid returns year after year. So schemes like this add the extra masala to the usual routine investment option that would attract the investor who is averse to risk and does not want to make a risky investment. Let me explain how.

Let us take the case of a middle class gentleman who is of our father's age (In his fifty's) A person of our fathers age prefers to stay away from the stock market because the chances of the money disappearing are pretty high. Investments in the stock market is considered a gamble and hence they prefer to stick to debt instruments like PPF, Fixed Deposits etc. They know that the NAV of a ULIP grows every year based on the market performance and if you guarantee them that the NAV in the first 'X' years at maturity they would believe that the returns would definitely be more than debt instruments and come forward to invest in them. Increased investments means increased revenue for the fund house, hence such schemes have surfaced.

Let us now get into the real topic of discussion: Can ULIPs or MFs guarantee returns. Actually speaking "YES"

Before getting into the details of how, the simple answer to the question based on common sense is "YES". Do you really think reputed fund houses like ICICI or LIC would come up with schemes that guarantee the highest NAV reached by the fund in the first 'X' years at maturity when they feel that they cannot keep up their word? Definitely not. Now let us see how they would do it...

According to history of performance given by our stock market the market goes up every year. Even if there is recession in any particular year, in the next few years the market would recover and definitely beat its previous values. So now if you check these funds - the maturity date will be definitely 2 years or more after the date till which this maximum NAV is guaranteed. So even if the stock market crashes after the fund reaches its maximum NAV, the fund manager would have 2 or more years to ensure that the NAV of the fund crosses the highest NAV the fund reached in the stipulated period so that the fund house doesnt suffer any losses.

Imagine 10 people invest 10 lakhs each in a fund that does this guaranteeing thing. So a total of 1 crore is invested in the stock market at Rs. 10/- NAV. Assuming the highest NAV at the end of say 5 years is Rs. 75/- per unit and then the stock market crashes and the value comes down to Rs. 20/- per unit and you redeem your investment - the fund house has to pay you 75 lakhs instead of 20 lakhs. The value of your investment is only 20 lakhs but the fund house has to pay you 75 lakhs a loss of 55 lakhs per person. No company would incur such losses knowingly. That is why there is this gap of a few years between the highest NAV guarantee period and the maturity period. It is the fund managers responsibility to ensure that the NAV comes back to atleast Rs. 75/- so that the fund house doesnt suffer huge losses.

Below is what I would do if I were the fund manager of such a guaranteed returns fund:

In the first few years I would be like any other fund manager aggressively investing in stocks to increase the NAV of my fund every year to beat the market returns. But once the NAV value guaranteed return year is reached my investment MANTRA would be different

1. Have a good allocation towards debt instruments to ensure that the NAV of the fund doesnt get affected heavily even if the market crashes
2. Concentrate only on large or very large cap stocks. These are the stocks to rebound first even if the market happens to crash
3. Avoid small cap, medium cap and penny stocks. These are the stocks that are worst hit in case of a market crash
4. Avoid premature withdrawals. Premature withdrawals affect the fund managers ability to predict/manage the funds future performance

My aim would be to take all possible steps to ensure that the NAV of my fund does not fall too much...

Finally - Would I recommend such schemes? YES. These are good schemes that would attract even the risk averse investor. As always equity investments would give better returns than deposits in banks and hence these are good options for long term investors...

Happy Investing!!!

ULIP’s De-Mystified

When you walk into your nearest bank or financial advisor to plan for your tax or to plan for your retirement, in all probabilities the first option they suggest is an ULIP. A ULIP stands for Unit Linked Insurance Plan. A ULIP is nothing but a mixture of Mutual Funds and Insurance bound together and sold to investors like us. You may be wondering, how do all these people suggest you to go for a ULIP. The answer is plain and simple. MONEY. Yes, you read it right. It is because of Money. Most ULIPs offer hefty commissions to the agents who sell those products and hence all of them suggest these products to their prospective customers invariably.

ULIPs are very good investment options provided we understand them properly and buy only what we want and not what our agent wants us to buy. Before getting into those details let us first understand what a ULIP is and how it works.

What are ULIP’s?

In terms of functioning, ULIPs are very similar to Mutual funds. To know what Mutual funds are Click Here. A ULIP can be considered as a type of mutual fund that provides you insurance benefits and that too, to the extent you want. The money you invest would be converted into units just like in MFs and invested in the stock market and also you would be charged an amount out of your premium to provide you the insurance coverage you want. For a layman we can assume that

ULIP = Mutual fund + Insurance

How do ULIPs work?

Let us say you invest Rs. 10,000/- in a ULIP plan with NAV at Rs. 20/- per unit. There would be a number of charges associated with the ULIPs. Let us say they constitute 15% of your investment hence Rs. 8500/- Ideally speaking you should be getting 425 units but you may not get it fully. As there is insurance provided to you, the ULIP house would deduct a portion of your money for that. Lets say it is 2.5% then that would leave Rs. 8250/- for buying units. Which means you would get 412.5 units during your first year. Every year when you invest, after deducting all the charges units would be allocated to your account. The policy duration typically is around 10 years or more. You would be provided insurance coverage only during the policy tenure.

Assuming you had paid your premiums every year properly and at the end of 8 years you have 4000 units. Now let us say due to some unforeseen circumstances, the policy holder dies the ULIP company would pay the nominees (Our parents or spouse) the insurance amount plus the market value of the 4000 units that we hold. Lets say the unit price at that time is Rs. 45/- and your insurance was Rs. 2 lacs then your family would get Rs. 1,80,000/- (Fund value) + Rs. 2,00,000/- (Insurance Amount) which works out to a total of Rs. 3,80,000/-
Assuming we outlived our policy duration of 10 years and at the end of it we hold 5500 units and the unit price at that time is Rs. 55/- then we would get Rs. 3,02,500/-

Either ways we are getting a good yield on our investment. (Provided the equity markets fare well and the fund house does not suffer huge losses like what has happened now)

What makes these ULIP plans attractive for us, as an Investor?

1. Insurance benefits
2. Tax exemptions under sec 80c
3. Various investment options (These days ULIPs offer us the convenience of choosing the type of fund in which we want our money to be invested. We can opt for higher equity allocation during initial stages and then switch over to balanced or conservative funds which invest in debt market for capital preservation during the end of the tenure)
4. Disciplined investment approach (ULIP investments expect us to stay invested for a long term, a minimum of 3 years or more and up to 10 – 15 years. This makes regular savings a habit and we can save a lumpsum for our future usage)

With so many benefits all of us would be tempted to invest in these products. But these ULIPs do not come without any flipside. They too have their own drawbacks. There are few things we must consider before investing in these products. Let us check them out one by one.

1. Understand what ULIPs are

Many people invest in ULIPs without knowing that their money would be invested in the stock markets and it comes with its risks. Remember that our money would be invested in the stock market and the returns on our investment would depend on the performance of the stock markets. They function more or less like mutual funds and do not believe any false promises given by your agent. They may give you guaranteed return predictions, but they are only predictions and there is nothing like guaranteed returns when it comes to investing in the stock markets.

2. Decide on your RISK profile and fund type

Decide on how much RISK you can afford to take and decide on the type of fund you would want to invest. If you are in your 20’s and are a high risk investor opt for higher equity allocation funds. If you are a family man then you can opt for a balanced allocation to equities and debt market. If you are near your retirement you can opt for higher debt allocation. Most ULIPs offer facilities to switch fund types during the policy tenure. Decide and choose the fund that would suit your risk profile.

3. Compare the expenses charged on you

Most ULIPs have a number of charges associated with them. If you see the initial parts of this article you would have seen that out of a premium of Rs. 10,000/- only Rs. 8,250/- was converted to units. The remaining money was used to pay the charges/expenses associated with the fund. Some of those charges are:

a. Premium allocation charges

This is a front end charge that is deducting from your premium. The money that is left after its deduction is invested into the funds that we choose. The insurer uses this to meet most of its expenses. In some ULIPs it is as high as 60% in the first year and in some it is as low as 0%. This charge would keep going down every year.

b. Mortality charges

This is the actual cost of the life insurance coverage provided to us. This may be deducted from our fund on a monthly/quarterly/yearly basis. This depends on a number of factors like age of the investor, his health condition and the amount of coverage sought. The charges for this are almost similar in all ULIPs

c. Fund management charges

This is deducted as a fixed percentage of the fund value and is used to manage the investment of the funds. It is one of the most important charges because; every year as your fund value goes up this charge would go up.

d. Policy administration charges

This charge is usually deducted from the fund value every month. It can be a fixed amount throughout the policy term or vary at a pre-determined rate.
The costs associated with ULIPs vary with products, the age and health of the investor, the tenure of investment, insurance amount sought etc. Experts suggest that the internal rate of return (IRR) is the best parameter to judge the total impact of these costs for an investor.

Let us assume you invested Rs. 1 lakh a year in a ULIP for 15 years. At an annual rate of return of 10% you would get Rs. 26.8 lakhs after the 15 years. With zero charges you would have got back Rs. 35 lakhs. This means that the costs associated with your investment have eaten nearly 8 lakhs of your money. The greater the gap between the IRR and the assumed rate of return, the higher are the costs associated with the policy.

You can ask your insurance company for the IRR of the policies you have or for the policies you are planning to take.

4. Set your Insurance target

A general thumb rule is that your insurance requirement is around 7-10 times of your annual income. Do not ask for huge amounts of insurance through such ULIPs. They eat a fat portion of your investment. Instead opt for pure term insurance products and choose only the amount of insurance you want from the ULIP.

5. Keep a track of your fund performance

Once you have bought the policy, do not forget it. Keep a track of how it is performing and if required decide upon changing to a different fund type. After all it is our hard earned money and we have all the rights to decide what we want to do with it.

6. Other Parameters

Certain parameters like the number of free switches you can make from one investment plan to another, ease of premium payment options, pre-closure charges etc also need to be considered before finalizing our investment.

Important Note:

ULIPs are long term investment instruments. The charges associated with the funds during the first 2 or 3 years is usually high in almost all funds and it is important to stay invested at least for 7-10 years in the ULIP to reap the benefits of the equity markets and also to recover the costs that were deducted from our investments. Most agents sell them as short term products but in most cases the market value of our investment is not even as much as the amount we paid them. So it is advisable to stay invested throughout the policy duration to achieve maximum benefits out of our investments.